How Are Equity Home Loan Rates Calculated?

by HomeLoan.com

Home equity loans provide a way for real estate owners to tap into the value of their property without having to put it up for sale. By attaching the property as collateral to the home equity loan, lenders are able to offer borrowers lower interest rates and a higher loan amount than they would be able to with a personal loan. Understanding how the rates are calculated is the first step in educating yourself about equity loans.

Function

A home equity loan is used to secure funds that would otherwise be unobtainable, unless one sold the property in order to get at the equity. Instead, an equity home loan provides the borrower with a lump sum of cash using the property as equity. These funds can be used for any purpose so long as the property securing the loan stays intact.

Types

There are two main types of equity home loan rates. The first type is a fixed rate, and the second type is a variable rate. Generally, a fixed rate is set by a bank's rate committee. This rate may be set higher or lower in order to attract business, or to maximize profitability. Since a fixed rate is set by the bank, it can be any amount, but it is usually tied unofficially to an index interest rate such as the PRIME rate. A variable loan rate is calculated by adding a specific amount to an interest rate index.

Size

Equity Loan rates tend to be set in a range between 1.50 percent below and 1.50 percent above the PRIME rate. A equity loan with a variable interest rate is calculated by adding a certain amount to an index rate, which is often the PRIME rate. A variable rate loan may be set anywhere from 1.50 percent below PRIME for borrowers with excellent credit, but usually only as a special promotion, up to 1.50 percent above PRIME for borrowers with good credit. Borrowers with lower credit may see 2.0 or 3.0 percent above PRIME depending upon market conditions and the real estate used. Fixed rates are not directly tied to the index, but when they are set by the bank, they tend to follow approximately the same rules.

Considerations

Because a variable rate fluctuates with the debt markets, it is important to understand that the interest rate may increase. If it does so, the payment will generally increase as well. Thus, it is important to be able to make not only the initial payment, but a slightly higher one as well.

Warning

Because an equity loan uses real estate as collateral, the borrower could lose their home eventually if the loan is not repaid. Thus, it is important to fully understand the implications of an equity loan prior to entering into a contract.